Update from the ATO on recent compliance activity, areas of concern with SMSFs and the ATO’s future priorities

Keynote address to the CPA Learn from the Masters SMSF Conference and Expo 2014

Sydney, Thursday, 17 July 2014 and Melbourne, 24 July 2014

Introduction

Warning:

This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

End of attention

Thank you for inviting me to talk to you today. It’s an important part of our job at the ATO to converse with stakeholders and I always welcome the opportunity. Everything my team and I do is about strengthening the framework in which self-managed super funds operate; talking with practitioners is an invaluable part of this.

I’d like to start by taking a quick look at the sector and then discuss emerging risks, industry activity and trends and some key SMSF issues before moving onto the compliance program and the new penalty regime. I’ll finish by telling you about some of our new products and services.

Shape of the SMSF sector

At March this year there were 528,701 self-managed super funds with over one million members.

The number of SMSFs continues to grow:

on average 34,500 SMSFs are established each year

in the five years to 2013 SMSFs grew by 27 per cent, from just under 400,000 to over 500,000

90 per cent of funds established in the 10 years to 2012 are still going.

SMSF assets total $558.5 billion (or 30 per cent of $1.84 trillion in all super assets as at March 2014).

And younger people are establishing SMSFs. At the end of June 2013, only 18 per cent of SMSF members were under 45 but for new funds, the proportion of members aged under 45 has increased annually from 23 per cent of members of funds established in the 2007-08 financial year to 33 per cent of members of funds established in the 2011-12 year, a 10 per cent increase.

Return on assets

In 2011-12 the estimated return on assets for the SMSF sector was positive (1.0 per cent) though noticeably lower than the returns of 2009-10 and 2010-11 (7.7 per cent for both years). The trend in estimated returns is consistent with that for other regulated super funds.

2011-12 SMSF Statistical Overview

For more on the SMSF sector, you can refer to the SMSF Statistical Overview 2011-12 (released in December last year) on the ATO website. We expect that the 2012-13 SMSF Statistical Overview will be published in December this year.

Emerging risks

We monitor the SMSF industry continuously to ensure that funds are paying the correct tax and that their sole purpose is to meet members’ retirement income objectives. In addition to our standard activities – addressing auditor contravention reports and issues found in the SMSF annual return – we will also focus on a few particular areas of concern this financial year. I’ll highlight these now.

Dividend washing

Dividend washing is a share trading strategy that enables a taxpayer to access double the franking credits attached to fully franked dividends even though the taxpayer effectively holds only one parcel of shares. The shares are purchased in a special market that allows the taxpayer, often an SMSF, to re-acquire shares with a dividend attached, after the ex-dividend date, allowing them to take advantage of the additional franking credits to offset their tax liability or receive a refund of the excess imputation credits.

In the 2013-14 Budget, the government announced that tax legislation would be amended to close this loophole, taking effect retrospectively from 1 July 2013. Our position was issued in April, in Taxation Determination TD 2014/10 Income tax: can section 177EA of the Income Tax Assessment Act 1936 apply to a ‘dividend washing’ scheme of the type described in this Taxation Determination?

In March, we sent self-amendment letters to about 2,000 SMSFs we identified as potentially having implemented this arrangement. Of the identified SMSFs, 38 per cent were in pension phase.

Overseas seminars

We’re keeping an eye on promoters who advertise questionable SMSF conferences in overseas destinations. The promotions target SMSF trustees citing they can claim a deduction for the full cost of the travel, accommodation and meals component incurred when attending these seminars or workshops. The conferences appear to contain minimal training related to SMSF activities. Trustees contemplating attending such events should be aware of the potential to contravene the sole purpose test.

Home loan unit trusts

We’ve identified a potential home loan unit trust arrangement which involves the purchase of a residential property by a non-geared trust whereby units are purchased by the SMSF, related family trust and SMSF members. The purchase of the asset is effectively financed by the SMSF and the property is occupied and rented by the member. The rental income less expenses is paid out to unit holders but the proportion of distributions is not consistent year by year. Again, trustees should be aware of the potential to contravene the sole purpose test and/or of providing financial assistance to a member. If there is a form of ‘gearing’ or investments in other entities involved within the trust, then the SMSF may also be in breach of the in-house assets provisions.

Dividend stripping

A retirement planning arrangement we’re seeing also involves a private company with retained earnings distributed by way of a franked distribution to an SMSF in circumstances where the SMSF is entitled to a refund in relation to the franking credits attached to the distribution. It ultimately means that the earnings of the company are tax free in circumstances where the SMSF holds the shares for a short period of time at no risk to realise the cash and franking credits in the most tax effective manner within an income year.

We will issue a Taxpayer Alert in conjunction with an ATO view.

We encourage trustees and their advisers to carefully consider any arrangements into which they enter and whether these follow tax and regulatory requirements.

Monitoring industry activities and trends

In addition to these areas of concern, we will also take a close look at those SMSFs we think are taking undue advantage of the concessional rates of tax for complying super funds and entering aggressive tax planning arrangements.

Illegal early release

In addition to the newer risks on our radar, we’re still keeping an eye on illegal early release (IER) of super benefits as it remains a serious risk to the health of the super system. We continue to risk assess all newly registered SMSFs and take action to prevent suspect funds from entering the system. Those SMSFs which we do review as a result of our risk assessment but subsequently allow into the system must demonstrate they are complying with their requirements as trustees. Where they fail to lodge their first return by the due date, we will review them again to determine why they haven’t lodged.

Note too, that our strategies for dealing with IER go beyond the establishment phase. We’re focusing on SMSFs which have undertaken ‘traditional’ IER and those where IER is becoming more sophisticated – such as round-robin loans to purported unrelated entities. If we suspect that super savings are being illegally accessed we investigate the SMSF in question and remove it from Super Fund Lookup (SFLU). If we find IER has occurred, we will take further compliance action and impose a penalty/ies.

In 2012-13 we prevented 191 SMSFs from entering the system and removed 438 suspect funds from SFLU. In 2011-12 we prevented 298 SMSFs from entering the system and removed 427 existing suspect funds.

Lodgment

Although we have a number of strategies in place to address non-lodgment of SMSF annual returns, it can still sometimes be difficult to get the attention of these clients. In 2013 we decided to take additional steps to engage the trustees of SMSFs with two or more lodgment obligations overdue. Last September, 22,880 SMSFs with two or more annual returns overdue had their regulation details removed from the SFLU register until such time as they brought their lodgments up to date or, in the case of non-operating funds, wound up.

To date, over 20 per cent of these SMSFs have now either lodged or wound-up. We’re repeating the process this year. Affected funds won’t be able to receive rollovers or establish new contribution arrangements until they address their lodgment obligations. We will be reminding APRA funds and employers to check the regulation details of SMSFs on SFLU before progressing rollovers or contributions. SMSF trustees affected by this strategy will be notified in writing by the end of September.

This year, we’re also focusing on SMSFs who have never lodged; we will remove their details from SFLU. Where we have evidence that the SMSF is operating we will refer them for compliance action for non-lodgment. Where there is no evidence of the fund operating we will cancel their registration.

The ATO will also consider using our new administrative penalties to fine trustees directly for not preparing accounts in serious cases. I’ll discuss the new powers in more detail shortly.

Exempt current pension income

We continue to monitor the compliance of SMSFs paying pensions to ensure they are claiming the correct amount of exempt current pension income (ECPI). It’s important to be aware of some key issues that can affect a fund’s claim to ECPI. I’ll outline these now.

Missing the minimum pension payment

If a fund fails to meet the minimum pension payment requirements for an account-based pension (including a transition to retirement or allocated pension) in an income year, the super income stream will be taken to have ceased at the start of that income year for income tax purposes. This means the fund will not be entitled to treat income or capital gains as ECPI for the year.

Furthermore, from the start of the income year the account is no longer supporting a super income stream so any payments made during the year will be super lump sums for both income tax and Superannuation Industry Supervision Act purposes.

However, in limited circumstances, the Commissioner may allow a fund to continue to claim ECPI where certain conditions are satisfied. We’ve recently updated information to provide more guidance and include more examples on how we’ve been administering this exception.

For example, if a fund misses the minimum pension payment by more than 1/12th of the annual minimum pension payment required, the trustees must first and foremost be able to demonstrate that ‘matters outside of their control’ affected their ability to pay the minimum pension required. Only then can the Commissioner consider all the other conditions relevant to the exception.

Examples of matters outside of the control of the trustee that have resulted in the Commissioner granting the exception are:

the trustees of the fund had serious ongoing medical conditions that were supported by medical certificates

genuine errors were made by the bank and not the trustee and were supported by evidence from the bank.

The following circumstances are generally NOT considered to be outside of the trustees’ control:

a medical condition is not serious, is short term, no supporting documentation is provided

the circumstance that prevented the payment being made, eg a medical condition, is experienced by one/some but not all trustees; all trustees are equally responsible for running the fund and the Commissioner expects that if at least one trustee is not affected by the circumstance in consideration this trustee is able to carry out the necessary administration of the fund

a bank error occurred due to a mistake on the part of the trustee and not the bank

an error is made by a third party, such as an accountant, providing services to the fund; as we’ve highlighted in our publications and web content over the years, the trustee(s) are ultimately responsible for running the fund.

Segregation of pension assets

As income earned from assets set aside to provide pensions is exempt income, the issue of segregation is an important one in relation to how a fund calculates ECPI. There’s been much discussion around the Commissioner’s view on when an asset of a complying super fund will satisfy the definition of a ‘segregated’ asset. TD 2014/7 issued in April to deal specifically with the treatment of bank accounts. In the meantime, we continue to work on residual issues identified during the consultation process.

Apportionment of expenses

Last year the ATO started work on reviewing TR 93/17 and released draft tax ruling TR2013/D7, focusing on the apportionment of expenses incurred by a super fund where a fund derives both assessable and non-assessable income. The draft ruling sets out the Commissioner’s preliminary view on the tax rules relating to deductibility under s 8-1 of the income tax act for a super fund – I won’t go into the details here but you can find them on our website. We anticipate finalising our review of TR 93/17 in the near future.

You can always find detailed information and updates on SMSF-related topics on our website and I suggest checking in regularly.

ATO SMSF compliance approach

As part of our ongoing SMSF compliance program, we risk assess funds and then decide on appropriate follow up. In view of the new penalty regime that came into effect on 1 July 2014 (I’ll talk about this later) we’ll be more focused than ever on compliance breaches and how they’re reported.

Adopting a two-pronged strategy, we will monitor industry activities and trends, which I’ve already covered, and use a risk-differentiated approach to treat non-complying SMSFs based on the overall risk posed by a fund. We will analyse multiple indicators of non-compliance, including regulatory and income tax matters, drawing information from the SMSF annual return (SAR), auditor contravention reports (ACRs) and other sources including trustee and member records.

We will then determine a fund’s overall level of risk (low, medium or high) from both a regulatory and income tax perspective and take appropriate action to treat non-compliance. All SMSFs reported via ACRs will receive an audit, phone call or letter shortly after lodgment.

High-risk SMSFs will face a comprehensive audit of their tax and regulatory affairs. The audits will consider information reported on the ACR and any other source of concern. Where these SMSFs breach regulatory provisions under the new administrative penalties regime, penalties apply of up to $10,200 per trustee – this means $20,400 for a two-person fund with individual trustees. Where a fund has a corporate trustee that is one trustee, so that is one penalty of up to $10,200 with directors being jointly and severally liable for the payment. We will also consider whether trustees or directors of corporate trustees should be required to undertake education or rectify a contravention. If high-risk funds deliberately choose not to comply with their tax and regulatory obligations, we will use the full force of the law where necessary.

Medium-risk SMSFs will receive a telephone call, generally within 6-8 weeks of ACR lodgment. We will discuss the contravention and any other relevant matters and explain our reasons for concern but on this initial occasion be generally willing to give the fund an opportunity to self-address identified issues with no penalties applied.

Through streamlined treatment, we aim to achieve voluntary and timelier resolution of compliance issues, thus avoiding costly and complex audits further down the track. To help these clients to comply voluntarily, through our phone contact we will provide trustee education, directing trustees to our website, SMSF videos and publications suggesting trustees seek further assistance from their tax practitioner, advisors and SMSF auditor as required.

But, if trustees fail to engage with us and fail to self-address the issues raised or if further compliance issues arise we will very likely consider these funds for audit, possibly imposing penalties, among other firm outcomes.

Low-risk SMSFs will receive a tailored advice letter reminding trustees of their obligations and encouraging compliance in future. The issue reported in the ACR will be closed with no penalties applied. However, if trustees fail to rectify all issues in full or if further compliance risks arise, these funds may be considered for compliance action.

New penalties and ATO powers

As I’ve mentioned, from 1 July there are new penalties and we have new direction giving powers. We can impose penalties that are more in line with a breach than was previously the case but our discretion on whether or not to apply a penalty is limited. In conjunction with the new penalty regime is the new approach to ACRs which I just outlined. Not every ACR will lead to a penalty, but every ACR that leads to an ATO audit that then confirms an eligible breach will result in an SMSF administration penalty imposed on the trustees.

The accuracy and independence of SMSF auditors has always been critical to our compliance monitoring but now we’ll be relying even more on these auditors to identify and rectify minor breaches. I’ll return to auditors later. I now want to run briefly through the new compliance landscape.

In dealing with non-compliance by SMSF trustees, we may take one or several courses of action, depending on the seriousness of the contravention and the circumstances involved.

The Tax and Superannuation Laws Amendment (2014 Measures No.1) Act 2014 has given us three new regulatory compliance powers to deter and address non-compliance by trustees: education directions; rectification directions; and administrative penalties. If you come across a contravention, fix it. If it’s too late, then talk to us. We will work with you to avoid the worst outcome where we can. Our primary interest is the compliance of the fund. For penalties to be imposed there will usually need to be an unrectified contravention or repeat contraventions that lead us to start audit action.

Which brings me to my next point: while we’re certainly cracking down on serious and deliberate non-compliance we’re also always looking to see how we can help to improve the competency of trustees. The more ably SMSF trustees can meet their regulatory obligations the less likely they will be to contravene the law.

If we give an education direction, to comply trustees will need, within a nominated timeframe, to either undertake a free trustee education course via the SMSF trustee website (www.smsftrustee.comExternal Link) or attend a free SMSF trustee webinar run by the ATO.

The Self-managed Superannuation Fund Trustee Education program has been released by the Joint Accounting Bodies: the CPA (Chartered Practising Accountants), the ICAA (Institute of Chartered Accountants of Australia) and the National Institute of Accountants (NIA). I’d like to take this opportunity to thank you for partnering with your fellow professionals to provide this education. Your associations are the first to become approved providers and I congratulate you for your support for trustees and potential trustees. We encourage all trustees to undertake one of these courses even without an ATO direction.

Rectification directions will require a person to undertake specified action to rectify a contravention within a specified time and to provide evidence of compliance with the direction. Rectification generally involves putting into operation managerial or administrative arrangements that could reasonably be expected to ensure that there are no further similar contraventions. We will usually allow six months to fix the problem.

Probably the penalty part of the new legislation has received the most public attention. We’re optimistic that penalties received the first time around will be taken seriously and will reduce repeated compliance breaches. The highest administrative penalty is $10,200 and it applies to each trustee individually, that is a penalty of $10,200 per trustee not per fund. For a corporate trustee where there is only one trustee and therefore only one penalty, to be paid jointly and severally by the directors.

It’s worth emphasising that the penalty is to be paid from personal, not SMSF, assets. I should say too, because we’ve been asked about this, that trustees cannot get the penalty reimbursed as an expense of the SMSF. All trustees and directors are liable for the actions of their fellow trustees and directors. This might have an impact on the willingness of trustees who are not members from continuing in a trustee role.

Approved auditors

So, you can expect more assertive regulation from the ATO and changes in the way we operate. With auditors, as always, playing a key role in the landscape, we will continue to focus on their competency and compliance and offer as much support as possible. In addition to products such as the electronic superannuation audit tool (eSAT) and the Professional to Professional service, this year we will contact about 1,000 SMSF auditors where we have concerns about some aspect of their behaviour. We will also review and audit about 165 auditors including a small number of high-volume auditors to confirm that they are undertaking proper and comprehensive SMSF audits.

We’re running a pilot program with auditors that tells us every SMSF they’ve audited in a year. We cross check this against returns to see if there are any problems. We’re working to ensure that the data provided to us about independent audits on the SAR is correct and are currently identifying and taking action in cases where auditor details have been misused. This is a concern to us as it compromises the integrity of the audit and of the SMSF sector as a whole. Where warranted, we will take serious action against the people concerned.

We’re here to help

So, we have a regime in place we believe will enable us to address contraventions appropriately, we have a well-established and ever improving compliance program, and auditor registration with ASIC has been operating successfully for a year now. As one commentator noted recently: ‘… as far as the future is concerned, trustees haven’t seen what the ATO is capable of doing’. This is true in more ways than one. We’re in the process of reinventing ourselves: listening closely to our stakeholders and changing what needs to be changed to make the ATO a more efficient, effective and responsive organisation.

An important part of our role is education. To quote the title of one of our SMSF videos: you can’t do it all yourself. Self-managed super funds are not for everybody. At the very least they require significant work, time, diligence and knowledge. On this last point, we can help. We’ve been running an SMSF education campaign for some time now and before I conclude today I’d like to talk a little about it.

We’ve recently wrapped up a very successfully subscribed SMSF Professionals webinar series about our new compliance approach and powers. Close to 6,000 people from around Australia attended and the feedback was overwhelmingly positive. Almost 100 per cent of participants said they’d like us to use this channel for future updates to SMSF professionals and we’ll certainly be doing so. If you go to our website, you can see a video of one of the webinars alongside questions and answers from the series.

Over the past few months, we’ve been gradually releasing the 20 videos in our SMSF YouTube suite. Topics range from the general (what’s involved with an SMSF) to the complex (business real property, LRBAs, paying an income stream). To date, the videos have been viewed over 50,000 times. Yesterday we launched two more: Loans, and Early AccessExternal Link and Investment StrategyExternal Link

Remember, our free electronic newsletter SMSF News (you can subscribe online) is a key source to find out about our new products.

Conclusion

ATO Commissioner Chris Jordan stated earlier this year, ‘Rethinking and questioning our core business is a critical part of our transformation of the ATO. By 2020 our goal – our vision – is to be: 'a leading taxation and superannuation administration known for our contemporary service, expertise and integrity’Footnote1.

I hope I’ve shown you how in Superannuation we’re continually improving and adding to our services and support in line with this vision. Our aim is to simplify our interactions with you, provide more timely advice and create products to support the industry. We want to make it easier for people to do the right thing and be more engaged in planning for their retirement. As always, we welcome your feedback and input.

Thank you.

Footnote 1

Reinventing the ATO, Chris Jordan, address to the Tax Institute of Australia 29th National Convention, Hobart, 27 March 2014.

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